IFRS 16: Identifying a Lease

At inception of a contract, an entity should assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract gives the right to control the use of an identified asset (‘underlying asset’) for a period of time in exchange for consideration (IFRS 16.9). The right to control the use of an identified asset can be split into:

a/ the right to obtain substantially all of the economic benefits from use of an identified asset and

b/ the right to direct the use of an identified asset.

Paragraph IFRS 16.B31 neatly summarises the assessment of whether a contract is, or contains, a lease in a decision tree which is reproduced below. See also Examples 1 – 10 accompanying IFRS 16.

Assessment whether a contract is, or contains, a lease under IFRS 16
Decision tree for identifying a lease under IFRS 16 (source: IFRS 16.B31)

An asset is usually identified by being explicitly specified in a contract. However, an asset can also be identified by being implicitly specified at the time that the asset is made available for use by the customer (IFRS 16.B13). Therefore, a lessee need not know the specific serial number of an asset to treat it as an identified asset (IFRS 16.BC111).

A capacity portion of an asset is an identified asset only if it is physically distinct. IFRS 16 gives an example of a floor of a building that can be considered as an identified asset. Subsurface rights can also be  identified assets. When a capacity portion of an asset is not physically distinct (e.g. 30% capacity portion of a pipeline or a fibre cable), it can be considered equal to an identified asset only if it represents substantially all of the capacity of the asset (IFRS 16.B20). Otherwise, a contract is not a lease contract. See also Example 2 accompanying IFRS 16.

The existence of substantive substitution rights for the lessor (supplier) mean that the lessee (customer) does not have the right to control the use of an identified asset, as the asset in question can be substituted for another asset. Therefore, a contract with a substantive substitution rights would not be a lease. Such a substitution right must be substantive in order to be taken into account, i.e. possible to be exercised in practice and economically beneficial. Substitution rights that do not change the substance or character of the contract because it is not likely or feasible for the supplier to exercise those rights, should not affect the assessment of whether a contract contains a lease (IFRS 16.BC113). As a result, an evaluation of whether a supplier’s substitution rights are substantive should exclude future events that, at inception of the contract, are not considered likely to occur. See paragraphs IFRS 16.B14-B19, BC112-BC115 and Example 4 accompanying IFRS 16 for more discussion on substantive substitution rights.

To control the use of an identified asset, a customer is required to have the right to obtain substantially all of the economic benefits from use of the asset during the period of use. The most obvious way of obtaining substantially all of the economic benefits from use of the asset is having exclusive use of the asset during the period of its use (IFRS 16.B21-B23).

The lessee should focus on economic benefits arising from the use of the asset (e.g. obtaining products), not from the ownership of the asset (e.g. tax credits) (IFRS 16.BC118).

A customer has the right to direct the use of an identified asset during the period of use only if either (IFRS 16.B24):

(a) the customer has the right to direct how and for what purpose the asset is used during the period of use; or

(b) the relevant decisions about how and for what purpose the asset is used are predetermined and:

– the customer has the right to operate the asset during the period of use, or

– the customer designed the asset in a way that predetermines how and for what purpose the asset will be used during the period of use

In making the assessment whether a customer has the right to direct how and for what purpose the asset is used, an entity focuses on the decision-making rights that affect the economic benefits to be derived from use of the asset in question during the period of use (IFRS 16.B25). Examples of such rights are given in paragraph IFRS 16.B26. Decision-making rights that do not grant the right to change how and for what purpose the asset is used are discussed in paragraph IFRS 16.B27.

As noted before, a customer has the right to direct the use of an identified asset if the relevant decisions about how and for what purpose the asset is used are predetermined and:

– the customer has the right to operate the asset during the period of use, or

– the customer designed the asset in a way that predetermines how and for what purpose the asset will be used during the period of use

The relevant decision can be predetermined by contractual provisions or by the design of the asset.

Protective rights of the supplier normally do not prevent the customer from having the right to direct the use of an asset. Protective rights may be designed to protect the supplier’s interest in the asset or other assets, or compliance with law and regulations. Examples of protective rights can for example (IFRS 16.B30):

  • specify the maximum amount of use of an asset or limit where or when the customer can use the asset,
  • require a customer to follow particular operating practices, or
  • require a customer to inform the supplier of changes in how an asset will be used.

A period of time may also be described in terms of the amount of use of an identified asset, e.g. mileage for a car or production units for equipment (IFRS 16.10).

Each lease and non-lease component in a contract should be accounted for separately (IFRS 16.12).

The right to use an underlying asset is a separate lease component if both the following criteria are met (IFRS 16.B32):

(a) the lessee can benefit from use of the underlying asset either on its own or together with other resources that are readily available to the lessee; and

(b) the underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract.

See also Example 12 accompanying IFRS 16.

A lease contract may include also non-lease charges (e.g. utilities in a lease of a building, or maintenance services in a lease of a car) that should be accounted for separately from a lease under other relevant IFRS, unless the entity (as a lessee) chooses to take advantage of a practical expedient described below.

Paragraph IFRS 16.15 allows an lessee (this is not applicable to lessors) to elect, for a class of underlying assets, not to separate non-lease components from lease components, and instead account for each lease component and any associated non-lease components as a single lease component.

See also Example 12 accompanying IFRS 16.

A lease contract may include an amount payable by the lessee for activities and costs that do not transfer a good or service to the lessee. For example, a lessee may be charged by the lessor an annual administrative charge which does not transfer a good or service to the lessee (is not distinct). Such amounts payable are not treated as separate component of the contract, but are considered to be part of the total consideration that is allocated to the separately identified components of the contract. Allocation of consideration is discussed below (IFRS 16.B33).

The consideration in the contract should be allocated to each lease component on the basis of the relative stand-alone price of the lease component and the aggregate stand-alone price of the non-lease components. The relative stand-alone price of lease and non-lease components should be determined on the basis of the price the lessor, or a similar supplier, would charge an entity for that component separately. If an observable stand-alone price is not readily available (and it usually won’t be), the entity should estimate the stand-alone price (IFRS 16.13-14).

See Example 12 accompanying IFRS 16 and the example below.

Example: allocating consideration to separate components

A lessee enters into a 4-year lease of a car. The supplier (lessor) will provide also maintenance services for the car during the lease. Total consideration to be paid for car lease and maintenance services amounts to $15,000 per year. Additionally, the lessee will be charged $500 per year as a reimbursement of car tax paid  by the lessor.

Total annual consideration payable to supplier of $15,500 is allocated to lease and non-lease components based on estimated stand-alone selling prices as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

 estimated SSPshare in total SSPallocated price
total16,500100%15,500
car lease14,80090%13,903
maintenance services1,70010%1,597

The consideration allocated to maintenance services is not included in the lease liability, it is expensed as incurred, unless the lessee elects the practical expedient set out in paragraph IFRS 16.15.

$500 payable as a reimbursement of car tax paid by the lessor is not treated as separate component of the contract as it does not transfer a good or service to the lessee (IFRS 16.B33).


A contract entered into by a joint arrangement, or on behalf of a joint arrangement, should be assessed from the perspective of the joint arrangement, not the joint operator/joint venturer. Therefore, a joint operator cannot state that a contract entered into by a joint arrangement does not contain a lease because each joint operator obtains only a portion of economic benefits from use of the underlying asset or does not unilaterally direct the use of the underlying asset (IFRS 16.B11, BC126).

See other pages relating to IFRS 16:

IFRS 16 Leases: Scope of IFRS 16

IFRS 16 Leases: Lease Term

IFRS 16 Leases: Recognition and Measurement of Leases

IFRS 16 Leases: Lessor accounting

IFRS 16 Leases: Transition from IAS 17 to IFRS 16

 


© 2018-2019 Marek Muc

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.